Economic Classroom Experiments/Price Discrimination

A supplier learns by repeated play how to extract the most profit from two buyers with known valuations when different forms of price discrimination are allowed.

Overview

Level

Any level

Prerequisite knowledge

None

Suitable modules

Any

Intended learning outcomes

1. Understand price discrimination and how to calculate buyer surpluses.
2. Price discrimination is good for the supplier and the fully discriminating monopolist makes the most profit.
3. Suppliers may have perverse incentives that are unhelpful to some consumers, e.g. an airline deciding not to improve the uncomfortable seating in economy class to encourage business customers to pay more to get a premium service. This is profitable if business customers are more sensitive to comfort and tourists to price.

Computerized Version

A computerized version of this experiment is available on the Exeter games site.

You can quickly log in as a subject to try out this individual progress experiment. You may also find the sample instructions helpful.

Abstract

Students play individually in the role of a supplier, whose objective is to extract as much profit as possible from two buyers played by the computer, when various forms of price discrimination are allowed. The buyers' valuations are different and the supplier knows the value to each buyer of 1 item and of 2 items, i.e. there are four valuations in all. Students play four consecutive games where different degrees of price discrimination are allowed: no discrimination, partial discrimination based on buyer (3rd degree), partial discrimination on quantity (2nd degree) and full discrimination on both buyer and quantity (1st degree). Playing multiple rounds of each game allows students to experiment with different prices and understand how the buyers behave.

Discussion of Likely Results

Each item costs £5 to produce and the buyers' valuations are as follows.

Buyer	1 item	2 items
A	£20	£20
B	£30	£40

Buyers prefer to buy 2 items rather than 1 if indifferent in terms of their valuations.

With no discrimination, charge £20 per item and sell 1 to A and 1 to B, profit £30.

With buyer discrimination, charge A £20 per item and B £30 per item and sell 1 to A and 1 to B, profit £40.

With quantity discrimination, charge £20 for 1 item and £30 for 2 items and sell 1 to A and 2 to B, profit £35. (B has the same surplus of £10 for both 1 item and 2 items and therefore buys the larger quantity.) It is easy for the students to think that the prices should be £20 for 1 item and £40 for 2 items. The key for them to understand this is that then buyer B will buy only 1 item and get a surplus of £10 rather than a surplus of 0 for buying 2 items.

With full discrimination, charge A £20 for 1 item and B £40 for 2 items and sell 1 to A and 2 to B, profit £45. One could mention that while full discrimination is worst for the consumer, it is the most efficient (highest buyer+seller surplus).